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Spending Is The Tax

May 13, 2009

by Jerry O’Driscoll

In an opinion piece in today’s Wall Street Journal, Martin Feldstein argues that “Tax Increases Could Kill the Recovery.” He harks back to the Depression experience and Japan’s in 1997. If Milton Friedman is correct, however, the tax increase has already occurred. For Friedman, government spending is the tax — the measure of the extraction of real resources from the economy by government. Tax finance, deficit finance, and inflationary finance are the 3 possible methods of financing the extraction. Each method has its own effects and certainly can create its own problems. Because of uncertainties regarding the effects of spending and future levies (tax, deficit or inflation) on their own incomes, citizens may not immediately adjust their spending. But the average citizen understands the government spending must be financed.

Notably absent from recent discussions of current deficits and future taxes is what I might call the Argentine option: that a future government will shrug its collective shoulders, tell the bondholders that the debt was run up by someone else, and offer them a take-it-or-leave-it haircut on their holdings. Wait—didn’t someone just stiff Chrysler’s secured creditors this way? Add this to the list of reasons that Obama is looking a lot like Peron.

The Federal Government has a sweet thing going with China, but it may come to an end soon. By pegging the Yuan to the U.S. Dollar, their demand was stimulated. Thus the U.S. Treasury could tap a new source of income, the Chinese people. But eventually even that well is going to dry up.